OPEC's plan to boost oil prices is in trouble

OPEC and its allies have capped crude oil production since late 2016 to help reduce global inventory levels and underpin prices.

OPEC is forecasting that supply growth from non-OPEC producers will now outstrip demand growth this year.

Improved productivity and higher prices is contributing an increase in US crude supply.

OPEC’s attempts to underpin crude oil prices are being undermined by the US oil industry.

In its latest oil market report released on Wednesday, the group revised up its forecast for non-OPEC supply growth in 2018 to 1.66 million barrels per day, up 280 million barrels per day from its previous forecast.

Importantly, the group sees demand growth only lifting by 1.62 million barrels per day this year, hindering attempts to help reduced global inventory levels and support crude prices.

And the US shale oil industry is largely to blame with the group estimating that US oil supply will lift 10.2% this year, accounting for nearly 90% of total non-OPEC supply growth.

This chart from the Commonwealth Bank helps explain the threat posed by the US crude producers.

Source: Commonwealth Bank

Productivity per rig is improving rapidly, something Vivek Dhar, Mining and Energy Commodities Analyst at the Commonwealth Bank, says makes US production the main oversupply risk to the oil market.

“Oil rig productivity looks close to setting new highs if current trends continue,” he says.

“The EIA is forecasting US oil production will lift 14.8% to 10.70 million barrels per day this year, before rising another 5.3% to 11.27 million barrels per day next year. The increase in output has been helped by the rapid expansion in US oil rigs… [which now sit at the] highest level since April 2015 having surged around 150% since May 2016.”

And with productivity of existing wells already improving, Dhar says there’s also an abundance of supply waiting in the wings.

“The backlog of oil wells to be completed continues to keep rising too,” he says.

“The EIA reported that drilled but uncompleted (DUC) wells have increased to a multi-year high of 7,601 at the end of February.

“These DUC wells just require fracking to bring oil to the market. And since these wells require less labour to bring online, they are a source of low cost production.

“If oil rig drilling proves uneconomical, we could see companies look to draw down on their DUC wells, keeping US oil output higher for longer.”

Given the threat posed to bringing the crude market back into balance, Dhar says OPEC should focus on discouraging marginal US producers from bringing on additional supply rather than capping its own output in the hope it will lead to a reduction in global inventory levels.

“OPEC should be targeting a price closer to US marginal production than clearing excess inventories, because the latter can be self-defeating if it results in prices high enough to incentivise more US oil production,” he says.

Either way, Dhar expects oil prices will to continue to drift lower by the end of 2018.

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